Canadian Dollar Shifts Lower on Surprise Inflation Undershoot

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The Canadian Dollar extended a trend of weakness against the majority of its peers after headline Canadian inflation numbers undershot expectations by a sizeable margin, however, a stubborn trimmed mean inflation reading offers some lingering support.

The standout figure was a -0.1% month-on-month core CPI inflation reading for June, which was well below the 0.5% the market was expecting and May's 0.4%.

Given the Bank of Canada places great emphasis on developments in core inflation the print will bolster market expectations for an end to the Bank's interest rate hiking cycle.

Canadian government bond yields were lower in reflection of this evolving expectation, in turn weighing on the CAD.

Statistics Canada reported the year-on-year core inflation rate now stands at 3.2% in June, down on 3.7% in May and below expectations for 3.5%.

The headline CPI inflation figure was at 0.1% m/m (0.3% exp. 0.4% prev.) and 2.8% y/y in June (3.0% exp. 3.4% prev.).

This marks a substantial downshift in inflation and suggests the Bank of Canada can be confident it is on track to return inflation to its 2.0% goal.

Canadian yields could come under further pressure as investors discount an ending in the BoC's rate hiking cycle, which can in turn weigh on the Canadian Dollar.

Following the data release the Pound to Canadian Dollar exchange rate was 0.20% higher at 1.7328, the 2023 high is at 1.7733. The Dollar to Canadian Dollar exchange rate was up 0.16% at 1.3220 and the Euro to Canadian Dollar exchange rate at 1.4854.

"While the deceleration was largely due to gasoline prices today being compared to the very peaks seen in 2022, there were also some encouraging signs of weakening price pressures elsewhere as well," says Andrew Grantham, Senior Economist at CIBC Capital Markets.

However, Grantham cautions against calling the all-clear as the Bank of Canada's preferred measure - the trimmed mean reading - was at 3.7% y/y, which was higher than expectations for 3.4%.

"With CPI-trim and median showing little further progress towards the target band there remains a very real risk that interest rates could be raised again after the summer," says Grantham.

This observation could offer some support to the Candian Dollar even if the headline numbers show a welcome cooling in inflation.